42 Pages Posted: 7 Feb 2004
Date Written: April 2005
We examine whether liquidity is priced in corporate yield spreads. Using a battery of liquidity measures covering over 4000 corporate bonds and spanning investment grade and speculative grade categories, we find that more illiquid bonds earn higher yield spreads; and that an improvement of liquidity causes a significant reduction in yield spreads. These results hold after controlling for common bond-specific, firm-specific, and macroeconomic variables, and are robust to issuers' fixed effect and potential endogeneity bias. Our finding mitigates the concern in the default risk literature that neither the level nor the dynamic of yield spreads can be fully explained by default risk determinants, and suggests that liquidity plays an important role in corporate bond valuation.
Suggested Citation: Suggested Citation
Lesmond, David A. and Chen, Long and Wei, Jason Zhanshun, Corporate Yield Spreads and Bond Liquidity (April 2005). 14th Annual Conference on Financial Economics and Accounting. Available at SSRN: https://ssrn.com/abstract=495422 or http://dx.doi.org/10.2139/ssrn.495422
By Meb Faber